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Shadow Elite: Derivatives, A Horror Story

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Strange as it sounds, my experience mapping under-the-radar power in Communist Poland, as a social anthropologist, helped me identify a new breed of modern-day power broker here in the U.S. Unaccountable operators are increasingly shaping public policy to suit their own interests, a disturbing trend I examine in my book Shadow Elite.

But perhaps not as strange as this sounds: Gillian Tett's fieldwork studying marriage rituals in a mountain village in Tajikistan helped her, years later, understand how risky derivatives proliferated, and went unnoticed, until they helped detonate the global financial system. Tett is also a social anthropologist by training. Now she's a top editor/journalist for the Financial Times, by trade, and she joins others with anthropological know-how offering crucial insights on derivatives and the "dark markets" that have been key areas of combat in the financial reform fight being waged on Capitol Hill.

Tett is the author of Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe. Last fall in Anthropology News, she made this comparison:

...bankers (like Tajik villagers) operate as a tightly defined group, with specific cultural patterns and a quasi language (or jargon) of their own. Also like Tajik villagers, bankers are generally trained to think in rigid "silos" and, as a result, find it hard to see how their overall system operates, or to see the contradictions in their own rhet­oric and internal organizations.

From the outside and with hindsight, the contradictions now seem glaring. Inside this closed culture, the ideals of the free market are repeatedly espoused, but not upheld. Derivatives, the exotic financial contraptions that vastly enrich the banking business, have flourished in the shadows, not in the open marketplace.

As I discuss in Shadow Elite, bankers capitalized on this aura of unmatched complexity, ever-changing technologies, and unstoppable financial "innovation", all during an era when deregulation had become the norm. They used jargon, as Tett points out, and also a stranglehold on information as weapons to obscure, making effective oversight very difficult. She elaborated in the FT on the warring Wall Street "tribes" within a single firm, and how the derivatives tribe came to dominate.

Groups such as Citi or Merrill appear to have developed a more hierarchical pattern, in which the different business lines have existed like warring tribes, answerable only to the chief. Moreover, the most profitable tribe has invariably wielded the most power - and thus was untouchable and inscrutable to everyone else. Hence the fact that, in this tribal culture, nobody reined in the excesses....

No one reined them in within the firm, the ratings agencies, or Washington. Anthropologist of finance Bill Maurer explained to me the 'complexity' narrative.

[It is one] that empowers the [bankers and their lobbyists] who can say, 'listen Congress, listen policymakers, we're the ones who know what's going on. So just back off. There's no way you can understand unless you have a degree in advanced math or advanced physics.'

Damning evidence of this kind of hubris can be seen in a statement to Congress in 1998 - when the derivatives timebomb might have been defused - from then-deputy Treasury Secretary Lawrence Summers. He clearly internalized the idea that the Wall Street pros knew best.

....the parties to these kinds of contract are largely sophisticated financial institutions that would appear to be eminently capable of protecting themselves from fraud and counterparty insolvencies.

Who else was backing off? Gillian Tett takes a hard look at her own adopted field, journalism. After sketching out how the financial banking "village" operated, she then tried to understand, as both a reporter and anthropologist, why the media largely disregarded derivatives, even as their significance and threat was growing bigger minute by minute, trade by trade. While working at the Financial Times, she began to see a similar narrative taking hold in newsrooms: that derivatives were too hard to report on, and too boring to read about.
She says this:

...in the debt and derivatives world .... bankers generally loathed publicity and would rarely give "on the record" quotes. Moreover, it was difficult to get price or trading data since deals were typically made in private, not on public exchanges, and discrete events seemed few and far between. The debt and derivatives markets did not create "stories"--or not as defined by the Western press.

Shadow Elite column editor Linda Keenan, who worked in TV financial news in the earlier days of derivatives, seconds this assessment, pointing out that in television, there's the added barrier of needing visuals: how do you put a picture to a derivative?

With journalists stumped, could anyone in the Washington power "village" stand in the way of runaway derivatives, and the banks that wanted to keep them unregulated? Ironically, there were few policymakers more capable of understanding derivatives or their real world impact than Clinton Treasury Secretary Robert Rubin and his deputy Lawrence Summers. And both were there when derivatives could have been at least partially reined in before they became, to quote Warren Buffett, "financial weapons of mass destruction." Instead they did exactly the opposite, blocking key regulation at pivotal moments, as we saw in Summers' remarks above, with Rubin going on to benefit from this deregulated Wild West when he left Washington and returned to Wall Street as a top executive.

Here again, taking an anthropological view can be instructive. Consider the elite conclaves both came from, and the biases and potential conflicts attached to them. Rubin originally came to Washington after decades at Goldman Sachs, a firm renown for its culture of invincibility. Summers came from a somewhat similar culture - Harvard - with ample faith in both himself and the efficacy of the free market.

Their boss, President Clinton, was intent on being the pro-business "New" Democrat. In the last two months, all three have tried to distance themselves from their roles in letting derivatives go unchecked. (And in true shadow elite fashion, none of them have faced the consequences of their actions. In fact, the only ones to really suffer from the failure of the elite are the non-elite, millions of regular people who've lost their jobs, houses or savings.)

And derivatives remain unchecked. Just because the economy cratered doesn't mean that all these money-printing machines have disappeared. According to calculations by Bernstein Research, Goldman Sachs could lose 41 percent of its profits if the new derivatives regulations pass. Banks generally don't break down their figures on this part of their business (surprised?), but it seems fair to estimate the percentage of the bank revenue that comes from derivatives is solidly in the double-digits (at some it could be more than 50%) To put this in perspective, imagine a food company that gets half its revenue from selling products that go totally unregulated by the FDA, and whose practices are hidden from both regulators and journalists.

Tett notes sociologist, philosopher and anthropologist Pierre Bourdieu as arguing,

...elites .... invariably try to hang onto power--not so much by controlling the physical means of production, but by also dominating the cognitive map, or social discourse. What really matters ...is not what is publicly discussed, but what is not discussed. Social silences, in other words, are crucial.

Her message: when the people in power insist a little too hard that there's no story to be found, start digging in. Tett says this should be a wake-up call for journalists and anthropologists, to question the people drawing that cognitive map. One reviewer dismissed this as "preachy" advice. It might be, if she wasn't dead right.

Linda Keenan edits the Shadow Elite column.